"It's Not Your Father's Stock Market"

One of the most amazing statistical facts of all time was uncovered last month by Bloomberg, revealing the number of stock indexes had ramped up way beyond the actual total of listed issues, says Alan Newman, editor of CrossCurrents.

The number of constituent companies declined from 7487 in 1995 to 4333, a decline of 42%. However, from 2010 to 2012, the number of indexes quadrupled to 1000 and has since actually more than quintupled to well over 5000.

We’ve commented for years that the arena is no longer your father’s stock market. The metamorphosis is about as bizarre as anyone could possibly imagine. It’s no longer a market of stocks but a market of indexes.

One of the excuses given by the financial industry for the hijacking of stock picking and value is the development of new and allegedly “smart” indexes, based on customized criteria.

The expected outcome has been the denigration of value as espoused by Graham & Dodd. To a large degree, stock picking is dead, replaced by the notion that the index offers a safer approach.

In a market where the index takes precedence, such as today, there may be the appearance of less risk, but the assumption of greater leverage (seen best in margin debt tallies) belies far greater risk than generally acknowledged.

Total margin debt (includes NYSE & NASD) has set four records in the last four months and has now cratered our liquidity measure to its lowest level ever.

While the 2015 liquidity bottom only resulted in a modest correction, the bottoms in 2000 and 2007 imply the 2015 corrective move was merely an outlier.

In less than five-and-a-half years, the S&P has nearly doubled, yet earnings are down and have been lower in each of the intervening years.

Whatever reasons we see advanced for the bull case at this point make no sense. We now believe the odds favor a third bear market as significant as those in 2000-2002 and 2008- 2009.

We cannot stress strongly enough how much risk there is on the long side at this juncture. The best time to be in stocks is when valuations and leverage are low.

The worst time for longs is when both valuations and leverage are high and both are now at or near record all time highs. Downside risk is likely as great as the 2000 and 2007 peaks — as much as 50% downside risk.